Germany must turn to domestic economy for growth

As in China and Japan, a shift may be under way in world’s No. 4 economy

by David Marsh

Mon 19 Mar 2012

At a time when both China and Japan have flirted with trade deficits in past months, Germany, the world’s No. 4 economy, is still chalking up large surpluses. Last year’s current account surplus of 5% of GDP was one of the biggest in the world outside the oil-exporting nations. But multiple economic changes in Asia and Europe indicate that, in coming years, the Germans will find worldwide sales of ‘made in Germany’ products a lot tougher. Self-interest suggests a shift towards home-grown stimulus.

Slower economic growth in emerging economies, especially those hit by energy hikes or their own export slowdowns, as well as forced austerity in Europe, will put German exporters on to the back foot. The changed tempo of the world economy may bring a phase where internal demand rather than exports becomes the main impetus behind the German economy. Such a shift would be highly welcome - not only as a way of rebalancing the international economy but also as a means of ensuring the survival of economic and monetary union (EMU).

To reduce exporters’ vulnerability to Europe’s economic and political vicissitudes, Germany has built its foreign trade prowess on large portions of trade outside as well as inside Europe.

The euro has lent great support to these efforts, by preventing competitors from devaluing in Europe and by lowering the price of German goods on third markets (compared with the level that would theoretically have prevailed if we still had the D-Mark). German exports have flooded growth markets in Asia, Africa and America, boosted not only by the legendary quality and reliability of German goods but also by the additional euro-induced factor of price competitiveness. Over the last decade German foreign trade with Asia has risen 8% annually, double the increase in Germany’s trade with EMU members.

These rosy years of export prowess now probably belong in the past. Clouds over the long-term health of the Chinese market have been heightened by the massive Chinese trade deficit in February, which – although it may be a one-off - underlines how export-led growth is slowing, a development that will slow the heady pace of import expansion.

In Europe, the price of continued euro membership for southern countries will be years of painful adjustment and belt-tightening. This will lessen demand for German capital goods. As the election rhetoric of French president Nicolas Sarkozy has shown, anti-European Union protectionist feelings are rising throughout Europe. EMU can be maintained over the longer term probably only if Germany suffers higher inflation and a substantial cut in its trade surplus with its neighbours. So Germany’s optimal path will need to combine higher wages, more domestic consumption, and more subdued export growth to Europe and emerging markets.